TFSA Pension: How to Earn $5,000 Per Year and Pay None of it to the CRA

Investors have an opportunity to get attractive tax-free returns on savings while reducing portfolio risk.

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Canadian retirees are searching for ways to get better returns on their invested savings without increasing their tax bill or being hit by a clawback on their Old Age Security (OAS) pensions. One way to achieve this goal is to use a Tax-Free Savings Account (TFSA) to generate passive income.

TFSA benefits

The cumulative maximum TFSA contribution limit is $88,000 in 2023. That’s a large enough portfolio to generate decent passive income to complement a company pension, Canada Pension Plan, and OAS.

The great thing about the TFSA is that any interest, dividends, and capital gains that are generated inside the portfolio can be removed tax-free, and the full amount stays in your pocket. The Canada Revenue Agency does not tax TFSA income and won’t use the earnings when calculating net world income that determines if a person gets hit with the OAS pension recovery tax.

OAS clawback

The OAS clawback kicks in once net world income tops a minimum threshold. In the 2023 income year, that level is $86,912. Every dollar above this amount triggers a 15% reduction in the OAS that will be paid during the July 2024 to June 2025 period. For example, a person with net world income of $96,912 in 2023 would see their OAS get cut by $1,500 next year. That’s a big hit.

Owning income-generating investments in a TFSA rather than inside a taxable account is one way to reduce net world income. This is why it makes sense to use up all of the TFSA contribution room.

Good investments to generate TFSA passive income

People who do not need quick access to their invested funds and are not comfortable putting their savings at risk of capital losses should consider holding guaranteed investment certificates (GICs) as part of their portfolio. Rates on GICs have increased dramatically in the past two years as a result of the sharp spike in interest rates and soaring bond yields. At the time of writing, investors can get rates above 5.20% on four-year and five-year GICs from some Canada Deposit Insurance Corporation (CDIC) members. Rates on terms of one year to three years are currently above 5.5%.

The peak on GIC rates is likely in sight, however, so the renewal rates investors will get once the GICs mature could be meaningfully lower.

Dividend stocks are another option for generating passive income. Several stocks with long track records of dividend growth now offer yields above 7% as a result of steep declines in their share prices. Owning dividend stocks comes with risk, as we have all been reminded in the past year, but the share prices of stocks that continually raise their distributions usually bounce back from downturns.

BCE (TSX:BCE), for example, has increased the dividend by at least 5% annually for the past 15 years. The core revenue stream comes from essential mobile and internet service subscriptions, so BCE should be a good stock to own during a recession.

At the current share price of nearly $51 BCE is probably oversold. Investors who buy at the current level can get a 7.5% dividend yield.

Financial stocks are also out of favour and offer attractive yields. CIBC (TSX:CM) now offers a yield of 7.25%. The bank remains very profitable and has a solid capital cushion to ride out some economic turbulence.

Pipeline stocks appear cheap today. TC Energy (TSX:TRP) has increased its dividend annually for more than 20 years and expects its capital program to support ongoing dividend increases of at least 3% per year over the medium term. TRP stock now offers a yield of nearly 8%.

The bottom line on TFSA passive income

In the current market environment, investors can put together a diversified portfolio of GICs and top dividend stocks to reduce risk and boost yields. It is quite easy to get an average yield of 6.25% today on such a portfolio. This would generate $5,000 per year of tax-free passive income on a TFSA of $80,000.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of BCE.

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